Due diligence scoring - what criteria are important to SCAN members?

What are the key factors that SCAN members consider when deciding to invest or not? In our April CSR Angels meeting, a member asked a perceptive question about our due diligence scoring system relating to evaluating a company’s cash flow profile. The question prompted me to dig back into our scoring data to see if what we tell people about our investment criteria is supported by our evaluation and investment activity. (More on that cash flow question in a future post.)

Some quick background: VentureSouth groups conduct due diligence on companies that pitch and report the results through a standardized scoring system based on 10 criteria. Without boring you with the details, we’ve scored dozens of companies using this system – both companies we’ve invested in and those we’ve passed on - which allows us to calibrate the relative attraction of an opportunity against others we have seen.

If you’ve seen any of us present on panels or on Crowdr, you can probably guess that we say the three key criteria in deciding to invest are (i) quality of the management team, (ii) size of the market, and (iii) ability to exit.

Does the scoring of candidate companies and our investment decisions support that position? Well, yes but not completely.

I looked at the criteria with the biggest difference in score between companies we’ve invested in and companies we haven’t. The top three are “management team,” “competition,” and “deal terms.”

Quality of the management team is therefore without doubt the most important thing we analyze. Actually, what we are evaluating is suitability: can the team presenting this plan deliver on it? If members believe they can, we invest; if not, we don’t.

“Competition” came as a surprise to me: more on this in another blog post.

On “deal terms,” if the valuation is too high, the deal too complex or lacking opportunity for oversight, or has some other atypical feature, the scoring is much lower - so we pass. It is notoriously difficult to value early stage companies – as Matt’s last education session showed. And yet, investors must remain disciplined on valuation – otherwise the “winnings” from the investment “wins” cannot make up for the inevitable “losses.” So it was particularly encouraging to me to see that detailed reflection on deal terms from the members – and willingness to pass on investments that look appealing but are overpriced – is evident in the behavior of our diligence volunteers.